Capital Asset Pricing Model

Abstract

Two general approaches to the problem of valuing assets under uncertainty may be distinguished. The first approach relies on arbitrage arguments of one kind or another, while under the second approach equilibrium asset prices are obtained by equating endogenously determined asset demands to asset supplies, which are typically taken as exogenous. Examples of the former range from the static arbitrage arguments which underlie the Modigliani-Miller theorem to the dynamic arbitrage strategies which are the basis for the Option Pricing Model: such arbitrage based models can only yield the price of one asset relative to the prices of other assets. The Capital Asset Pricing Model (CAPM) is an example of an equilibrium model in which asset prices are related to the exogenous data, the tastes and endowments of investors although, as we shall see below, the CAPM is often presented as a relative pricing model.